Startup Options Valuation by Financing Stage

ff Venture Capital
www.ffvc.com
@ffvc
teten.com
@dteten

About
We created this model with the purpose of valuing options for an illiquid, early-stage start-up.
It is particularly valuable to assess equity compensation in the form of options paid out to employees and i
Also, dilution effects are calculated in seed and Series A financing rounds.
It's also helpful for understanding the value of the common equity over time.
Unlike every other model we've seen, this is based on real probabilities of success for your startup,
drawing on data from the most thorough research study we've seen on the topic:
Returns of Angel Investors in Groups. Kauffmann Foundation study, November 2007.

Assumptions
Given an early-stage startup is typically such a blank slate,
we think the safest way to value it is to assume it will have the same return characteristics
as other angel or VC-backed startups as per the Kauffmann Foundation's "Returns of Angel Investors in G
( http://www.kauffman.org/research-and-policy/returns-of-angels-investors-in-groups.aspx )

We ignore any correlation between year of exit (i.e., how many years old the company is) and valuation at
Instructions
Note that cells in blue or yellow are inputs. Cells in black text are outputs.
The top part of the spreadsheet is the assumptions,
where the angel investment and the exit multiple are assumed.
The sensitivity tables at the bottom illustrate the total amount of
compensation (salary plus equity options) that the employee in this scenario

will earn.
Credits
Developed by
David Teten (Partner, ff Venture Capital ; Teten.com, info@teten.com)
and Raul Trevino (CEO, Participa.me, rtrevino@participame.com)

If you have feedback on the model, contact info@teten.com . We are very interested in suggested
additional improvements and will try to reflect them. However, we cannot provide you with user support.
Most recently updated June 6, 2012.

Sources/Additional Reading

http://www.kauffman.org/research-and-policy/returns-of-angels-investors-in-groups.aspx.
http://www.bothsidesofthetable.com/2010/07/22/want-to-know-how-vcs-calculate-valuation-diff
http://www.markpeterdavis.com/getventure/2009/07/management-equity-compensation-bench
http://www.markpeterdavis.com/getventure/2010/02/how-to-calculate-sweat-equity.html
http://www.markpeterdavis.com/getventure/2010/02/make-sure-sweat-equity-vests.html
http://angelsoft.net/a/venture-valuation
http://www.bothsidesofthetable.com/2010/07/22/want-to-know-how-vcs-calculate-valuation-diff
http://www.bothsidesofthetable.com/2009/11/04/is-it-time-for-you-to-earn-or-to-learn/
http://www.slideshare.net/weblover/mint-founderinstitute-accounting
http://www.avc.com/a_vc/2009/03/what-is-a-good-venture-return.html

t to employees and investors.

your startup,

Angel Investors in Groups" report.

is) and valuation at exit.

in suggested
u with user support.

n-groups.aspx.
lculate-valuation-differently-from-founders/
compensation-benchmarks.html
at-equity.html
uity-vests.html

lculate-valuation-differently-from-founders/
or-to-learn/

From the original blog post at Teten.com introducing this model.

Valuing Startup Employee Options

This is the third of three blog posts on financial modeling for startups. The first was on best practices

Ive often found it helpful to have on hand a simple model showing the impact of each financing stage
Download the Original Startup Options Valuation model here.

In particular, this model is designed to help all team members understand the impact of dilution on th
a model that you can email to everyone in the firm, because then everyone sees clearly that youre co
message to the whole team (including outside consultants and the advisory board, if any). Such a mo
founders looking for a co-founder or key employee.

While working on my most recent startup, Navon Partners, we were fortunate to have Raul Trevino, a
Columbia MBA, interning with us. Like me, he had the pleasure/pain of being trained as an in
graduated, hes now Founder and CEO of a Latin America-focused based startup, Participa.me (I part
blog post, and worked closely with me to develop this financial model. We had a simple balance s
earlier master template financial model, but this model is more suitable for use in employment negot
Enter Raul:

This capital table startup options valuation model was created with the purpose of valuing options for

In my previous life as an investment banking analyst at Citi, we used to spend hours deriving the
capital (WACC) for a particular company. We used to take medians and means of unlevered bet
companies. Daily updates of the risk-free rates and corporate bond spreads were mandatory, even
other consisted of only a couple of basis points.

In banking, a lot of my time was spent on modeling cash flows. Projections were based on dozens
pricing, production, marketing spend, etc. Market assumptions including market share and macroeco
financial assumptions such as capital structure and taxes had to be considered. After capturing all of
had to do sensitivities on the dozen or so that were most important.

In the discounted cash flow (DCF) methodology, the terminal value carries a lot of weight and c
more) of the total value of the firm. Needless to say, a lot of time and analytics was dedicated to the t

Given all the tweaks and adjustments involved in calculating the overall value of a standalone firm, o
valuations that we came up with. In the end, we presented the results that made the most sense to o
I heard David Teten once say if you torture the data enough, itll confess.

Valuing startups is a far fuzzier process. In particular, most valuations are negotiated rather than deri

To bring the case in point to life, I will introduce my startup, Participa.me. Participa.me is an online ma

For my start-up, I built a very robust operational and financial model with a detailed revenue build up
having confidence in my financial projections, I am realistic enough to admit that at this stage (pre
may be hard for potential investors to believe them. (Im hopeful that they will change their minds so
validation from potential customers!).

The valuation method I discuss here is how people (other than friends, family and fools) really inves
the DCF methodology, it is quite simple and is based on one thing: returns, based on a range of poss
investor has a hurdle rate and based on that they choose whether they want to invest or not.

By definition, IRR is calculated using amount invested, amount received at some point in the future, a
flows. When an investor looks at a company, he projects himself into the future and calculates the
time. Based on his ownership share of the company at that point (most likely a diluted percentage),
Couple with his personal hurdle rate and take-home amount, he figures out what his post-money sh
order for him to make that personal hurdle rate. To illustrate the VC method with real numbers, let
valuing start-ups.
Financial Model

The good news for us engineers (me, by academic training) that favor science over art in valuation is

As a classic VC rule of thumb, according toJohn Frankelof ff Venture Capital andothers, a third of star
the remaining third are where the returns are. If a third of those, or about 10% of the portfolio, work o
The bottom line is thatthat the top 10% of deals provide 90% or so of the returns.(David Teten: Joh
we invest heavily in our winners as they start to pull away from the pack, so that even if a third of our
capital.)

Based on these estimates from some domain experts, we built the attached model to figure out ho
could potentially be worth at exit based on different capitalization rounds and how much could the pa
If you have any comments or questions, please enter your comments at the bottom of this blog post.
Download the Original Startup Options Valuation model here.

nd the second was a template financial model for a startup.

ble for sharing with everyone in the company. I couldnt find one online, so I built it.

Startup Options Valuation by Financing Stage

Data We Know Today

General
Today's Date
# Hours/Week Worked by Employee
# Hours/Month
Risk Free Rate
Startup Premium

1/30/2015
45
188
1.5% 10-Year Treasury Yield as of 6/5/12
0.0% The cost of equity is normally calculated as
Cost of equity = Risk free rate of return + Premium expected for risk.
or
Cost of equity = Risk free rate of return + Beta x (market rate of return- risk free rate of return), where Beta= sensitivity to movements in the relevant market.
Given we're using an NPV (below) which adjusts for risk by summing all possible outcomes, including the likely outcome of failure,
we believe it's appropriate in this instance to discount this equity at the risk free rate.

Options Characteristics
# Years Vesting
Strike Price (Pre-Money Valuation)
Granted to (Employee Title)
% of Options Exercised (assuming no auto-vesting at cha

4
$4.89
CEO
100%

Valuation at Exit based on Angel Cash on Cash Multiples

Exit Year
4
Exercise Date (assumed at exit)
1/29/2019
Angel Investment Today
###
Cash on Cash Multiple
2.6x Default is 2.6x, based on Kauffman Returns study, below
Angel Investment Value at Exit
###
Kauffmann Research Study on 1,137 Angel "exits"
Exit Multiple Range
Percent of total exits
Average holding period for these exits (years)

<1x
52%
3

Mean return for Angels (over initial investment)

Mean IRR over 3.5 years

2.6x
27%

1x - 5x
34%
3.3

5x - 10x
7%
4.6

10x - 30x
3%
4.9

>30x
4%
6

100%

Implied cost of equity

Source: "Returns of Angel Investors in Groups". Kauffmann study, November 2007, downloadable at http://www.kauffman.org/research-and-policy/returns-of-angels-investors-in-groups.aspx .
Note: Mean IRR calculation not reconcilable to Kauffmann's figure of 3.5 years average holding period.

Start-up Capitalization
CEO Options
Option Pool excl. CEO
Angel Round
Series A Round
Series B Round
Pre-Money
Pre-Money
Angel
Angel
Post-Money
Series A
Series A
Post-Money
Series B
Series B
Post-Money
Common Shares
Total Shares % of Equity CEO Options Total Shares% of EquityOption Pool Total Shares % of Equity $ Investment
Preferred Shares
Total Shares % of Equity $ Investment
Preferred Shares
Total Shares % of Equity $ Investment
Preferred Shares Total Shares

Shareholders
Founders

1,000,000

1,000,000

100.0%

CEO

0.0%

All Other Employees

Angel
Series A Investors
Series B Investors

1,000,000

87.0%

1,000,000

58.0%

1,000,000

49.3%

1,000,000

41,667

4.0%

41,667

3.6%

41,667

2.4%

41,667

2.1%

41,667

1.8% $376,812

0.0%

0.0%

108,333

9.4%

108,333

6.3%

108,333

5.3%

108,333

4.7% $979,710

0.0%

0.0%

0.0%

575,000

33.3%

575,000

28.3%

575,000

24.9%

###

24.9%

0.0%

0.0%

0.0%

0.0%

305,102

15.0%

305,102

13.2%

###

13.2%

Pre-Money Valuation
Price / Share
Total $ Invested
Post-Money Valuation

###

41,667

0.0%
100%

0
41,667

###

108,333

0.0%
100%

0
108,333

###

###

575,000

0.0%
100%

0
###

575,000

###
$3.48
2,000,000
###

(1)

$0.00

CEO Total Compensation

$150,000
$12,500
$67

CEO Options Analysis

For data on typical equity cuts for different team members visit: www.teten.com/recruiting
Value of Vesting Equity per Month (assume
Vesting Options $ per Hour

$3,605
$19

Exit Year
Compensation Over Time Until Exit
Hourly
1
2
3
4
5
6
7
8
9
Base
$67
$150,000
$150,000
$150,000
$150,000
$0
$0
$0
$0
$0
Options
$19
$43,265
$43,265
$43,265
$43,265
$0
$0
$0
$0
$0
Total Annual Comp
$86
$193,265
$193,265
$193,265
$193,265
$0
$0
$0
$0
$0
Discount rate
99%
97%
96%
94%
93%
92%
90%
89%
88%
NPV Annual Compensation Until Exit
745,466
Important: the low discount rate assumed here only makes sense when taking account of the riskiness of this investment, by looking at the Mean NPV of all outcomes shown below.

10
$0
$0
$0
86%

Angel
Cash on
Cash
Multiple

Sensitivity Analysis - NPV of Total Annual Compensation

Total

Return Max. Return

Probability Range
745,466
52%
<1x
0.0x
0%
<1x
1.0x
34%
1x - 5x
5.0x
7% 5x - 10x
10.0x
3% 10x - 30x
30.0x
4%
> 30x
60.0x
100%

Mean NPV

1
$147,827
147,827
661,169
1,375,308
4,231,868
8,516,707
865,563

2
$293,512
293,512
803,135
1,512,102
4,347,970
8,601,772
###

3
$437,087
437,087
943,028
1,646,872
4,462,248
8,685,312

4
$578,582
578,582
1,080,876
1,779,646
4,574,728
8,767,351

###

Exit Multiple= multiple of entry investment, not a multiple of future financial metric (e.g. revenues)
52% of all returns in the Kauffman study were below 1x. For conservatism, we model these all as 0x returns.
4% of all returns in the Kauffman study were above 30x. We arbitrarily model these returns as 60x.

###

Exit Year
5
6
7
### $855,452
$990,886
###
855,452
990,886
### 1,598,109
1,851,120
### 2,631,263
3,047,842
### 6,763,881
7,834,730
###
###
###
###

###

###

8
###
1,124,358
2,100,465
3,458,385
8,890,065
###
###

9
10
###
###
1,255,896
1,385,529
2,346,197
2,588,370
3,862,980
4,261,714
9,930,111
###
###
###
###

305,102

###

305,102

0.0%
100%

$ 8,400,000
$
4.87
1,485,714
9,885,714

(1) Pre-money valuation are based on Angelsoft data found at http://angelsoft.net/a/venture-valuation , as of November 2011. (Site renamed to Gust.com)

CEO Base Compensation

Annual Base Comp
Monthly Base Comp
Hourly Base Comp

###

###

###

###

43.2%

###

% of Equity

96.0%

0
###

At Exit
% of Equity Valuation

1,000,000

43.2%
1.8%
4.7%

0.0%

###

283,309

283,309

12.2%

###

12.2%

100%

###

283,309

2,313,411

100%

###

100%

###
$
6.82
1,931,429
###

###
$9.04